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Chief Investment Officer's team, 20.09.2020
Let’s start with the fundamentals. Latest data confirm that the economic recovery has legs. Of course, the initial pace from the reopening is unsustainable but numbers from China, across industrial production and consumption, as well as the US Empire manufacturing and German ZEW all show robust gains. With regards to policy support, US fiscal stimulus is hostage to the current presidential campaign and visibility is low. The Fed’s updated guidance gave the clear message that rates will remain close to zero for years, but didn’t provide the short-term booster that some market participants were expecting. Against this backdrop, markets kept on losing momentum, with a clear fatigue on big technology names, but none in fresh stories, as illustrated by Snowflake’s share price doubling post IPO.
There is nothing to be surprised about. Uncertainty should last as long as containment issues in the Americas and India, as well as rising cases in Europe, are not solved, which means a credible vaccine being available. In the meantime, the US presidential election adds to uncertainty, being polarized by every event, the latest being the replacement of Mrs Ginsburg at the US Supreme Court. Italy is also voting today in a test of public support for government action, and the Brexit discussions will keep on blurring the outlook for Europe.
Our positioning is unchanged as we stick to the medium-term fundamentals: recovery and low rates. If anything, we may add to risk on a material weakness. Uncertainty doesn’t necessarily mean a correction however: the possibility of some compromises on US fiscal stimulus or on Brexit are not to be excluded. We see now the turbulence we were expecting for the summer and are not overly concerned. Stay safe.
The market reaction to the September Fed policy meeting, when chair Powell said rates would be kept low for years, was far from what consensus expected. Investors have learnt to equate monetary stimulus with financial asset inflation and Powell’s words should have sounded bullish indeed. Yet, DM equities closed in the red for the third consecutive week, with both the concern about peak stimulus being reached and the looming US presidential elections weighing heavily on investors’ sentiment. The lack of any incremental easing in the FOMC message represented an all-the-more obvious disappointment since Fed funds futures had already anticipated no rate hikes until well past 2023. Investors seeking positive catalysts to add to risk will most likely have little to look forward to until the US presidential elections, considering also that Congress might be unable to find a compromise on expired unemployment benefits before a new president takes office.
A slightly bearish development for the shorter term is that the quantity-on-loan on single US stocks has started to rise from a very low base, pointing to institutional investors de-risking their positions. Although this recent trend has room to continue given the very low short base, in the longer run markets remain well supported by zero policy rates, central bank asset purchases and a still relatively low equity positioning. Investors might be preparing for a contested election outcome, which would imply a recounting of votes and heightened uncertainty for at most a little longer than one month from the day of voting. In that case US assets, and in particular the US dollar, would probably underperform until visibility on the final outcome is regained.
From an intermarket point of view weaker crude prices are not boding well for the outlook of risk assets. The International Energy Agency expects “the recovery in oil demand to decelerate markedly in the second half of 2020” amidst rising Covid19 cases. That ties in with the OPEC’s Monthly Oil Market Report for September revising down demand for OPEC crude in 2020. Although further production cuts could buoy prices temporarily, the general backdrop does not seem conducive to much upside from current levels.
Readers following statistics about the presidential race will find it intriguing that one of the best indicators of the odds of the incumbent to be reelected is the performance of the stock market three months prior to the event. Negative returns in the August-October period would imply no second term for Mr Trump. Yet, with statistical data confessing to almost anything if they are tortured enough, one should not be surprised of the first false positive for this market metric, which has so far proven 100 percent right since 1984.
Fixed Income Update
Wednesday’s FOMC provided forward guidance on lift-off criteria and a new set of dot-plots. As we mentioned in the last weekly, the Fed expects to keep policy rates near zero until End-2023. Three critical criteria for lift-off were mentioned: full employment, inflation to reach 2%, and inflation to be “on track to moderately exceed 2 percent for some time.” The composition of asset purchases was not changed, indicating that the average duration of purchases will not change, resulting in the long-end curve steepening slightly.
There were no significant market movements across fixed income sub-asset classes last week. The Developed Market Treasury benchmark index led the pack with a weekly return of 0.47%. Spreads were mostly range-bound. IG spreads hovered around 120 bps while the HY and EM spreads oscillated around 530 and 345 bps.
Total YTD defaults inched up to 173 with two new defaults last week. At this point in 2019, 2016, and 2009, there were 80, 124, and 220 global defaults, respectively. Missed interest payments continue to lead the 2020 corporate default tally, with 66. Since the global financial crisis, this is the highest level when the number of defaults due to missed interest payments hit a full-year all-time high of 85. If the monthly average of seven defaults (measured from January to August) due to missed interest payments continues through the rest of the year, we can expect the 2020 total to be at or above 2009 levels.
Fund flows last week showed a more risk-on bias versus the broader markets. Total fund flows into the FI asset class decreased by 33% as compared to the previous week to $9bn while flows into equity-based mutual fund reached $26bn, the highest weekly fund flows since Q1 2018. Money market fund assets declined by almost $60bn, suggesting that idle cash is being invested, and the recent sell-off in risky assets have helped. IG Credit saw net outflows for the first time in the last four weeks. Developed Market funds garnered 95% of the net flows, indicating a slowdown in the preference for EM Debt versus the previous week.
It has been so far so good for GCC bond markets in September, with the flagship Bloomberg Barclays index up 0.14% this month as compared to -0.6% last month. The primary issuance pace continued with Emirates Islamic Bank and Gulf International Bank tapping the market last week to sell 5-year senior notes. Emirates Islamic Bank launched its Sukuk at 1.827%, which is the lowest ever coupon for a 5-year senior paper from any GCC banks. Both of these deals saw order books over 2x. We believe there may be some fatigue due to the large volume of issuance and expect the pace to slow down in the last two weeks this month.
September continues to see volatile markets, though global markets ended the week up 0.2%. Developed markets closed flat whilst emerging markets gained 1.6%, with China the lead contributor. The GCC markets saw the KSA Index gain 2.5% for the week, in line with a rise in oil prices and in the UAE, the Dubai index gained over 2% whilst Abu Dhabi was close to flat. China on the other hand, had a very stable week, with, encouraging trade data and freight volumes. The China US tech battle continues as the Trump administration on Friday said that it would ban TikTok and WeChat from Apple and Google app stores in the U.S., but the ban has been set aside as Pres. Trump has approved in principle the deal with Oracle and Walmart investing in TikTok Global.
The three major U.S. indexes have been down the last 3 weeks, but are still positive year to date. Last week saw them lose just half a percent, stemming the sharper fall seen in the 2 weeks prior. More volatility in the coming months is expected, particularly around the U.S. elections and the earnings season. And as the Democrats and Republicans remain at an impasse over further stimulus for coronavirus relief. Consensus is for earnings for the third quarter to drop by 22% from the year prior, according to FactSet. Additional support could bolster consumer spending, responsible for two-thirds of the U.S. economy.
Tech is watched closely as the largest constituent of U.S. indices. The FANG Index closed positively for the week, though Apple and Amazon have lost over 10% from their peak and are officially in correction territory. A surge in options trading focused on the mega cap technology stocks in recent months, has contributed to increased daily market swings. The concern around future tech performance continues, but tech outperforms not just on momentum, but because those are the goods and services in demand and where growth remains robust. The continuing volatility will offer buying opportunities in both tech and healthcare our preferred sectors and while we like the consumer sector for its stability, valuations here are headier than tech. Tech IPOs are gaining ground with software cloud company Snowflake valued at $66 bn and close to a 90 time sale to price multiple, as per analyst calculations. Palantir, a data analytic company is now in the news as the next major tech IPO, along with Ant Groups IPO.
Japan’s new Prime Minister policies, referred to as Suganomics, are broadly expected to be in line with former PM Abe’s, the big difference will be in structural reforms with plans to create a new ministry to promote digitisation, as well as support for regional bank consolidation. His driving through of reform is likely to be supportive of Japanese equities.
The spread of the virus appears to be stabilizing in the U.S. but retail traffic remains much below 2019. On the vaccine front trials continue. Nine candidates have entered a phase 3 trial, according to the WHO. BioNTech said it expects to receive emergency regulatory approval from U.S. authorities as early as October. Moderna said trial results may only be conclusive by December.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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